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The FDIC’s willingness to share losses on failed banks’ real estate loans could accelerate a drop in commercial property prices and push even more banks into failure, a Business Journal investigation has found.

The Federal Deposit Insurance Corp. often covers nearly all the risk of loan writedowns and foreclosure expenses for banks who acquire troubled assets from failed banks. Sources say many of the acquiring banks would rather foreclose than restructure loans.

With some experts predicting commercial real estate prices could fall up to 50 percent in South Florida, there is fear the foreclosed property could be sold for fire sale prices and make a bad situation even worse.

Although the FDIC says these loss sharing agreements are the least costly option in bank failures, the irony is other banks could be pushed into failure if they have to devalue the commercial real estate on their books if prices drop.

Through 2009, the FDIC made 94 loss-sharing deals covering $122 billion in assets.

“It’s like playing with house money,” said Derrick Gruner, an attorney with Miami-based Pinkert Law who represents lenders in foreclosures and modifications. “It determines whether a bank will play hardball or not on these loans. If you are in a casino and playing with house money, you might take more risks and not try to work a deal out.”

Gruner pointed to Branch Banking & Trust Co.’s acquisition of the failed Colonial Bank in 2009 as an example of a loss sharing deal with little risk for the acquiring institution.

BB&T received $15 billion of Colonial’s assets at a reduced value under loss sharing. The FDIC agreed to cover 80 percent of the first $5 billion in losses, but the reduced value means BB&T wouldn’t lose a penny if it had to write off $5 billion, or one-third, of the old Colonial loans, according to BB&T’s investor presentation. If the loan portfolio loses less than $5 billion, the FDIC would take 80 percent of the upside, with BB&T getting the rest.

For losses in excess of $5 billion, BB&T would have to pay 5 percent, with the FDIC picking up the balance. So, if the $15 billion Colonial loan portfolio becomes worthless, BB&T’s total loss would be $500 million.

Acquisitions of failed banks can be lucrative because the good assets generate profits.

Like with most loss-sharing agreements, the FDIC required BB&T to attempt a modification on every residential loan before seeking foreclosure. That requirement isn’t for nonresidential real estate under loss sharing.

Restructuring loans is a hassle because of the significant staff time, underwriting and legal expenses, so Gruner said the loss sharing system appears more conducive to foreclosing.

Since acquiring Colonial’s assets in August, BB&T has filed foreclosure lawsuits, seeking in excess of $2.5 million each, on at least eight South Florida non-residential properties included in the failed bank deal.

However, BB&T spokeswoman Cynthia Williams said foreclosure is a last option.

“The [loss-sharing] agreement allows BB&T to work with each individual borrower, consistent with our long-term credit policy,” she said.

Another loss-sharing agreement impacting South Florida’s real estate market is Miami Lakes-based BankUnited’s deal for the assets of the failed BankUnited FSB. Since that failure in May 2009, the new bank has sought foreclosure on at least 12 local non-residential properties with more than $2.5 million in mortgages outstanding under the old bank. BankUnited officials declined comment for this story.

In an interview with the Business Journal in January, FDIC Chairwoman Sheila Bair said her agency puts strict requirements on acquiring banks to attempt modifications in residential loss-sharing loans, although she said it is “a little different” for commercial loans, where modifications protocol is not as strict. FDIC regularly audits performance to make sure loss-sharing banks are minimizing losses to its insured deposit fund, she noted.

Even when commercial real estate borrowers default on loans, banks can save money and keep borrowers in business by modifying loans, said Joe Waites, a partner in Alpharetta, Ga.-based Minerva Consulting, which helps banks manage distressed loans. The problem is few banks have skilled staff to properly work out these deals, and FDIC loss-sharing agreements give them little incentive, he said. Waites has seen banks with loss-sharing agreements refuse to negotiate with commercial borrowers.

Since the FDIC covers loss of principal, but not interest income, banks want to move nonperforming loss-sharing loans off their books quickly through foreclosure or short sale, said Stephen D. Weiss, head of corporate development at Fort Lauderdale-based Foreclosure Response Team, which represents residential and commercial borrowers.

While some large banks have done commercial real estate modifications for her clients, Coral Gables attorney Rashmi Airan-Pace said she has not had success getting BankUnited to accept such deals. She said loss-sharing agreements give banks little reason to accept modified terms.

The aggressive tactics many banks have taken with commercial real estate loans in loss-sharing agreements will result in properties dumped onto the market at low values, said Reid Mack, a consultant with Miami-based Jackson Witter and Associates. This hurts other banks with similar loans as they feel pressure to write them down, he said.

That could lead to more bank failures – especially since most potential bank investors would rather acquire an institution with the FDIC’s protection than risk their capital by doing a deal on their own, Mack said. “You have the FDIC creating an unlevel playing field.”

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